Perhaps the most remarkable aspect of this bear market has been the debunking of what we at The Intelligent Investor have dubbed the “safe haven fallacy”. The economic nirvana of the past 16 years, in tandem with a strong bull market and low interest rates, lulled investors into a false sense of security. Many confused the long period of gently rising share prices with safety. And, unfortunately, their trusting natures were abused by short-term focused company managers and invest ment bankers, who structured businesses with fundamental defects.
Chief amongst these fatally flawed entities were the property trusts. The implosion of the Centro vehicles in December 2007 set the scene for what was to come. Almost all property trusts were swept up in debt-fuelled expansions over the past five years and, one by one, they have come crashing down. In recent months we’ve witnessed a series of massive capital-raisings that have wiped out tens of billions of dollars of securityholder value. These dilutionary raisings mean the peak prices of 2007 may not be seen again for decades.
Then there were the banks – another supposed “safe haven”. During the boom, many investors forgot that the banking business model – based on lending large amounts relative to equity – is inherently unstable. The devastating effect of this high leverage was seen internationally this year as economic conditions worsened more than most considered possible. Heavy writedowns resulted in the unprecedented effective nationalisation of doz ens of banks by governments desperate to prevent a financial meltdown. Shareholders, always on the bottom rung, were thrown off the rickety ladder.
And while the bull market for industrial stocks ended in November 2007, the resources stock bub ble kept right on inflating for another six months, with BHP Billiton and Woodside Petroleum, for example, hitting their share price peaks in May 2008. As the financial crisis seeped into the global economy, though, commodity prices, which had ridden the escalator up, came down by the lift.
The fashionable “stronger for longer” theme and rampant enthusiasm for the fast-growing “BRIC” economies were really just new ways of saying “it’s different this time”. As with the technology boom of the late 1990s, the Poseidon nickel boom of the late 1960s and the Dutch tulip mania of the 1600s, the play remained the same. Only the actors changed.
At The Intelligent Investor, we’re about prepa ration rather than prediction; so what are the best ways to protect a share portfolio in 2009?
First, keep avoiding companies with debt, par ticularly those with questionable prospects. While we’d normally be attracted to Wesfarmers by its hefty price decline, for example, its businesses are facing tough conditions at a time when its financial security has been compromised.
Second, beware the “expensive defensives”. It’s been a fortuitous decision to hold recession-resilient, ultra-high quality blue chips such as Woolworths and CSL over the past year. But, just as a rising tide lifts all boats, the ebb should eventu ally result in all falling. Those stocks still levitating because of the “safe haven fallacy” are in danger of toppling on the slightest bad news.
Third, remember the importance of dividends. All too often forgotten during the boom years, dividends have typically produced up to about half of total sharemarket returns over the long term. So we’re hunting around for companies with comfort able payout ratios that will be able to maintain or increase their dividends in future.
Finally, above all, look for high-quality, good-value businesses. These are the ones that will not only survive, but prosper down the track. Perhaps the most pertinent lesson from the past year is that there aren’t that many of them.
For anyone with a share portfolio, it’s been a horrendous year. And, while I can see that stock prices look cheap on the surface – which is reflected in more buy recommendations than we’ve had for years – recent events may have ramifications for many years to come.
If that’s the case, the sharemarket’s bumpy ride may not be over. We’re confident that there’s plenty of money to be made out of the panic currently gripping the market, but it’s certainly a time to tread carefully.